On Tuesday, I wrote this piece, suggesting that energy stocks could be set to finally make a comeback after seemingly inexplicable underperformance so far this year. The sector has lagged as stocks in general have recovered and even as the price of oil has also bounced significantly off the lows seen at the end of last year.
As I said then, there are many reasons for that, but ultimately, when you see a stock or sector performing contrary to logic, it is about confidence. News this morning of a big energy deal will go a long way to increasing that confidence and makes that prediction even more likely now than before.
After years of disappointment and reduced profits since oil crashed in 2014, traders and investors are understandably wary of the sector. To be fair to the oil companies, though, they are not responsible for any enthusiasm that may have led to optimism, and thus disappointment. They have been pretty clear throughout that the shock of two massive collapses in the space of six years, the first coming in 2008, would take some getting over.
So when Chevron (CVX) announced this morning that they were buying Anadarko Petroleum (APC) in a $33 billion cash and stock deal, it was especially significant. Obviously, that is a specific business decision and there are reasons that the deal makes sense, but it would not have even been considered if Chevron weren’t at least somewhat confident in the future of their business
Those specific factors point to why this deal can be so beneficial to Chevron, and why, as is so often the case in big takeovers, the initial drop in CVX makes the stock of the buyer attractive to long-term investors.
The buyout results in a type of synergy that is unique to the oil and gas industry. In buying Anadarko, Chevron acquires its assets, and the fact that the two companies were focused in pretty much the same areas makes that a huge positive. As this CNBC article points out:
“The companies say the deal creates a 75-mile corridor across the Delaware basin portion of the Permian. Stringing together continuous acreage allows companies to more efficiently carry out the advanced drilling methods needed to produce shale oil and gas.”
The dynamics of modern drilling are such that there are big advantages to large, contiguous operations and there are also advantages to combining assets in other areas such as the Gulf of Mexico.
Inevitably, as stock is part of the deal, CVX dropped on the news, but the company has said that if the deal goes through, and it is still subject to regulatory and shareholder approval, they will increase their share buyback program to offset the dilution. On that basis and given the competitive advantages that the deal promises for Chevron, their stock looks like a buy on the current weakness.
There are also broader implications for the sector, especially as we enter earnings season.
It suggests that the industry is more positive in their outlook for the coming years than they have been for a while. Assuming that Chevron’s competitors use similar models and data to predict their futures, that could mean that we will see some positive revisions to guidance from others in the business and makes beats of current estimates more likely.
All in all, whether this particular deal goes through or not, it reinforces the belief that energy will finally break out of its shell and start to catch up with the rest of the market.